Supreme Court of Texas, No. 13-0638 (May 16, 2014)
Chief Justice Hecht (Opinion)
Answering questions certified to it by the United States Fifth Circuit, the Texas Supreme Court provided much needed clarification for the Texas home equity loan industry. It held that a “modification” of a home equity loan need not satisfy all the stringent constitutional requirements applicable to the origination of such a loan as long as the modification does not embody a new “extension of credit."
“[B]ecause of Texas’s strong, historic protection of the homestead, home equity loans are regulated, not by statute as one might suppose, but by the ‘elaborate, detailed provisions’ of Article XVI, Section 50 of the Texas Constitution.” These provisions govern everything from, for example, where home equity loan papers can be executed to the requirement that such a loan cannot exceed 80% of the value of the homestead that secures it. The penalty for violating those “elaborate, detailed provisions” is severe. The lender or its assignee forfeits its security interest and all right to collect principal and interest on the loan—i.e., if a lender violates Section 50 of the Constitution and does not cure that violation upon notice, the borrower essentially gets a free house. The Sims case presented a question that arose more and more frequently in the financial crisis that began in 2008: If a borrower and lender agree to modify or restructure a home equity loan that met Section 50’s requirements when made, do those requirements have to be satisfied yet again at the time of the modification, based upon the facts as they exist at that time (e.g., does the 80% loan-to-value requirement have to be reassessed based upon the value of the home at the time of the restructuring, even if it was satisfied when the loan was originated)?
The Simses obtained a 30-year home equity loan in 2003. That loan met the standards of Section 50. The loan and accompanying security instrument obligated the Simses to repay the loan principal and interest. They also obligated the borrowers to pay taxes, assessments, and insurance, and authorized the lender to pay such amounts on the borrowers’ behalf if they did not do so, to protect its interest in the property, with any such advances becoming “additional debt of the [Simses] secured by” the home equity mortgage.
In 2009 and again in 2011, the Simses fell behind on their mortgage payments. Each time, they and the lender agreed to modify the home equity loan, rolling past-due amounts into the principal balance of the loan, but also lowering the Simses’ interest rate such that the Simses’ monthly payments were decreased both times. Each modification allowed the Simses to avoid foreclosure.
Nevertheless, after the 2011 modification the Simses sued, alleging that the modification constituted a refinancing that required compliance anew with all the requirements of Section 50. In particular, they argued that the 80% loan-to-value standard had to be reassessed as of the date of the modification, and that the modified loan violated that standard because the value of their home had dropped in the years after they first obtained their loan. The United States District Court dismissed the Simses’ claims. They appealed. And the Fifth Circuit certified questions to the Supreme Court of Texas.
Responding to the Fifth Circuit, the Texas Court ruled that a “modification” of a Texas home equity loan that does not expand the obligations made part of such a loan at its inception—i.e., does not embody a new “extension of credit”—is not subject to a re-application of the Section 50 standards. The Court explained that the “extension of credit” embodied in the original loan is not limited to principal and interest, but includes all the terms of the loan transaction—here, for example, the obligation to pay taxes and insurance and the right of the lender to advance such payments if necessary and to add those amounts to the borrowers’ debt. So, a modification that does no more than roll unpaid balances of those prior obligations into principal does not constitute a new “extension of credit.” In sum, the Court explained, “the restructuring of a home equity loan that . . . does not involve the satisfaction or replacement of the original note, an advancement of new funds, or an increase in the obligations created by the original note, is not a new extension of credit that must meet the requirements of Section 50.”
This ruling greatly enhances the flexibility of lenders and homeowners to deal with default situations and furthers “the fundamental purpose of Section 50: to protect the homestead,” by decreasing the need for and likelihood of foreclosure.
